Has (Financial) Regulation Over the Last Thirty Years Been One Huge Neoliberal Mistake?

(Spoiler: if the scholarship is any guide, the answer is, pretty much, no).

In 2009, Lord Adair Turner charged that:

‘An underlying assumption of financial regulation in the US, the UK and across the world, has been that financial innovation is by definition beneficial, since market discipline will winnow out any unnecessary or value destructive innovations. As a result, regulators have not considered it their role to judge the value of different financial products …’ (Turner Review at 49)

This is a provocative statement. Breaking it down, Lord Turner is making three separate, controversial claims. His first is that financial regulation across the world assumed that financial innovation was by definition beneficial. Second, the reason it was thought to be beneficial was that market discipline could be counted on to winnow out unproductive ideas. In other words, these financial regulators had accepted a fairly strong version of the Efficient Market Theory. Lord Turner’s third claim follows from this: if the market is the most efficient way to allocate resources, then financial regulators can only think of themselves as messing things up by intervening, whether to judge the value of financial products or to regulate them.

I am a legal scholar who writes about financial regulation. I have even written favorably about the main target of Lord Turner’s critique, the (now abolished) UK Financial Services Authority. Yet embracing private sector innovation and celebrating market discipline was not what I thought I was doing in my work. Nor did Lord Turner’s words resonate as an accurate account of what I thought my colleagues in the field were doing.

There is a sort of superficial affinity between the ‘innovation-loving model’ that Lord Turner describes and the receptiveness to innovation in the regulatory work that I know. From the 1990s until recently, the leading edge of regulation and its scholarship centred around the merits of developing more porous, collaborative regulatory models that could incorporate non-state forces, such as the market into decision making and evaluation. But if asked to define the goals of regulation and governance scholarship, of most financial regulation scholarship, or of my own work, I would have said that they were to strengthen and deepen public regulation to help it better meet the challenges of contemporary society, not to cede the field to private actors based on some sweeping confidence in market forces. Was I mistaken in what I thought we were doing?

This is a qualitative empirical review of the 198 US law review articles that were most influential within ‘flexible regulation’ scholarship between 1980 and 2012, which also discussed innovation. It is a chapter in Cristie Ford, Innovation and the State: Finance, Regulation, and Justice (Cambridge University Press, forthcoming fall 2017).

It turns out that flexible regulation scholars are a diverse bunch who advocated for regulation to be permeable to, not one, but three, main non-legal forces: market forces, deliberation and community norms, and industry standards. Collectively, the scholarship does not prioritize market forces or market-based evaluation methods above other forces or methods. It also contains rich veins of justice-oriented and deliberation-based claims. Moreover, relative to environmental and administrative law (the other main subject areas), the financial regulation articles are more skeptical about who will benefit from new innovations, and more concerned with specific new innovations and their risks. Several presciently identify some of the problems that gave rise to the financial crisis.

There are shortcomings, of course, as another of the book’s chapters discusses. In the years before the crisis, scholars and regulators sometimes misapprehended the nature and significance of private sector innovation, or underestimated its capacity to undermine regulation. Scholars spent too much time on technocratic regulatory design, and too little time explicitly invoking fundamental normative commitments. Scholarly work was also abused and misapplied in practice, and the strong civic republican anti-domination ethos that underpinned it was lost in translation.

Seemingly innocuous regulatory design choices can have enormous ramifications for our most cherished social commitments. Charting a path forward in a time of populist anger and great uncertainty demands a clear appreciation of the relationships between contemporary regulatory approaches, private sector innovation, and broader social welfare priorities including equality and voice. It is time for a fresh approach. We can build on the flexible regulation scholarship while also recognising innovation for the profound regulatory challenge that it is, and reclaiming regulation – especially financial regulation – for the fundamentally progressive project it has been since the 1930s.

Cristie Ford is Associate Professor of Law and Director at the Centre for Business Law, both at the Peter A. Allard School of Law at the University of British Columbia.